Letter to the MoD from the Government Actuary's Department (17 May 1999)

AFPS REVIEWCOST COMPARISON

1. As promised, I enclose with this letter a GAD note entitled "Comparison of Cost of APFS with other Public Service Pension Schemes". A comparison of costs was requested as background information to assist in the review of the Armed Forces Penson Scheme. There are, of course, many other issues which need to be taken into account in designing the appropriate benefit package.

2. I hope the note is sufficiently self-explanatory not to require much further explanation. However, it may be that members of the Review Team will have a number of questions, or wish further information on the reasons for any difference in the cost. As noted in the enclosed paper, the costings relate only to "pure pension" benefits, and do not include redundancy benefits or injury awards.

3. In previous years, there have been questions about the reasons for the significant difference in the pension cost between officers and other ranks. Part of the difference is obviously the superior scale of benefits, and earlier retirement age, which is applicable to officers as compared to other ranks. However, this is only a small part of the total difference in cost. The main reason for the difference is the much higher proportion of service personnel at the officer rank who continue in post until attainment of early pension age. The great majority of other ranks serve for relatively short periods, and do not persist in service until the earliest pension age. (Previous statistics indicated than only 10 per cent to 15 per cent of initial recruits in the "other rank" category survive to draw an early pension.)

4. Please let me know if further cost comparisons are required, particularly in relation to other public service occupational pension schemes.

COMPARISON OF COST OF AFPS WITH OTHER PUBLIC SERVICE PENSION SCHEMES

1. INTRODUCTION

The Review Team established to review the Armed Forces Pension Scheme (AFPS) has requested, as background information for the review, a comparison of the cost of the AFPS with the costs of the main public service occupational pension schemes. The table below shows the costs for the seven large public service schemes in the UK, together with the rate of contribution payable by the members of those pension schemes. The cost shown is an assessment by the Government Actuary's Department of the value of benefits accruing in respect of each year of pensionable service.

Cost of benefits per year of service

Member Contributions

(1) Armed Forces Pension Scheme

% of pensionable salary

(a) Officers

33.8%

0*

(a) Other Ranks

18.1%

0*

(a) Weighted average

22.0%

0*

Fast Accrual Schemes

(2) Fire Service

34.75%

11%

(3) Police Service

32.0%

11%

Normal Accrual Schemes

(4) NHS

20.0%

6%/5%

(5) Teachers

18.5%

6%

(6) Civil Service

18.0%

1 1/2%*

(7) Local Government

17.0%

6%(5%)

* Pay levels are adjusted, explicitly or implicitly, to take account of these contribution rates.

2. BENEFITS INCLUDED

The benefits included in this assessment of cost are only those benefits which a pension scheme would normally be expected to provide, either in the public sector or the private sector. These include benefits payable on normal pension age, voluntary withdrawal and ill-health benefits such as service invalidity pension (SIP). The costs do not include any provision for benefits initiated by the employer (such as redundancy benefits), or injury awards. Accordingly, the additional benefits applicable in request of an "attributable injury" do not form part of the normal pension cost quoted above.

3. METHODOLOGY

In order that a valid comparison can be made between the cost of the different schemes, it is important that a similar methodology is used to establish the cost in each case. The methodology adopted for determining the accruing cost of the schemes is the "Entry Age Method". Under this method, the cost of the benefits provided by the occupational pension scheme is determined for the typical new entrant, as that percentage of pensionable salary which, if paid throughout service, would be just sufficient to provide the promised benefits, assuming that future experience were to be in line with the actuarial assumptions adopted for the calculation.

4. ACTUARIAL ASSUMPTIONS

In order to achieve a valid comparison, it is necessary that the same financial assumptions are adopted for the assessment. The principal financial assumptions used are an investment return in excess of pension increases of 3 1/2 per cent per annum and an investment return in excess of earnings increases of 2 per cent per annum. By adopting the same methodology and the same financial assumptions, the cost of assessments should give a valid comparison of the different schemes. However, the comparison reflects not only benefit differences between the schemes, but also any significant demographic differences (such as in the average age of retirement, or the incidence of ill-health retirement). Further analysis and comparisons can be carried out, if required.

5. The cost of pension benefits is, or course, only one of the factors that needs to be taken into account in designing an appropriate benefit package for employees.